Sunday 26 October 2008

It is time to stop this policy incoherence

UK economic policy is sliding into total incoherence.

According to the Times, Darling wants to defend sterling, which has fallen remorselessly since this crisis began. He is going to achieve this by saying that the government "has not abandoned its fiscal policy rules."

Darling can say what he likes, the data tells us that the government abandoned its fiscal rules long ago. Last week, Darly talked about accelerating government expenditure. With tax revenues falling, this is a template for a higher public sector deficit. Besides, the UK government is likely to run up a deficit of at least 4.3 percent of GDP this year.

On the monetary side, the situation is also a mess. Interest rates are about to come down. This will further weaken sterling, and runs counter to Darling's aim of defending the currency. Afterall, there is nothing like reducing the rate of return on sterling assets to lead to a capital outflow.

As for inflation, again there is incoherence. The BoE have already cut rates, which are now negative in real terms. As expected, sterling crashed and inflation increased. Now, the MPC will cut again, which will further weaken sterling.

There is an alternative to this chaos; get the policy fundamentals right. The government needs to restore confidence in the public sector accounts. This means restraining expenditures, and if necessary, increasing tax.

For its part, the MPC should raise rates and ensure that they are positive in real terms. As for the financial crisis, the government should recapitalize them as planned, the FSA should be abolished and supervision returned to the Bank of England.

In the short run, this will generate a recession. This will be painful, but with a stronger, more credible policy framework, based on a sustainable fiscal policy and a credible anti-inflation strategy, the economy will bounce out of this slowdown more quickly.

8 comments:

Mitch said...

But it would mean Brown admitting he was wrong and that will never happen.

Anonymous said...

Exactly Mitch! We all know Darling is just Brown's puppet. And everything points to Brown not having a clue what's happening, and therefore no idea how to help rather than hinder the situation. He believes his own hype I'm afraid, and I see him esconced in No 10, telling all and sundry how he's got everything under control and its all hunky dorky, while outside in the real world we can see what's really going on. Sadly the 'Hitler in his bunker directing imaginary armies' simile is rather too close for comfort.

What we need is someone who has the credibility of actually having predicted the crisis to be in charge. At least then they might have some idea of what NOT to do, as much as what TO do. Sadly I don't think that is Cameron/Osborne (I am a Tory voter, but this pair look unspeakably wet. Things have changed, and we need less of the wishy washy Notting Hill crowd, and more steel - David Davis even).

The only politician who fits the bill is Vince Cable. Not a fan of the Lib Dems normally, but he is the only mainstream politico who brought up the credit boom before it blew up. Someone make him Chancellor. He can't do worse than the current bunch.

Electro-Kevin said...

Thank you, Alice.

I'm on record on Guido (and getting pilloried for it) for saying that the Tories, if they were honest at their last conference, should have explained that taxation would have to go up. What we actually got was "We can't rule out tax rises".

I'm of the mind that reducing interest rates will induce a bling-fest (as someone else has already mentioned) when what is badly needed is consolidation and a rebalancing of our economy. I'll certainly be blowing my savings if this happens.

In other words we need to be producing more stuff and selling it abroad.

Anonymous said...

You can strengthen your currency while reducing interest rates... all that is necessary is to encourage everyone else to cut by more. The snag, however, is that everyone has the same idea.

CPI is a distraction - a seriously lagging indicator. Oil $63 - and falling... rapidly... in spite of production cuts. This says a lot.

Anonymous said...

Alice, you are definitely not with the rest of the choir on this one. Everyone else seems to think more rate cuts and government expenditure will do the trick. It is a classic spend your way out of trouble strategy.

Anonymous said...

I don't know Alice, you are saying what a lot of people are thinking. We have seen this show before and it ends badly.

Anonymous said...

Alice,

Your suggestion of raising interest rates and increasing taxes and/or cutting expenditure during a recession has been tried before, in 1980/1, in fact. It did not end well. Unemloyment, which had been around 1mn in 1979, rose to over 3.5mn in 1983, which at the time represented around 12% of the workforce. Nor did the economy recover quickly, once the recession was technically over. Unemployment was still at 11% as late as 1987. Still, there was at least some point to this misery. RPI inflation had reached 21.5% in the second quarter of 1980. It responded predictably to 15% interest rates and double digit rates of unemployment.

This time round there is even less excuse for a policy of such excess. RPI and CPI inflation are respectively just 5% and 5.2%, and as the commodity price spike of the last 12 months drops out of the figures, both will fall rapidly. Indeed, if there is any danger to the 2% CPI inflation target, it is that we will undershoot it. The MPC needs to cut, not aggressively, as some commentators are suggesting, but in small but consistent increments.

I cannot help but think that your desire to see house prices continuing to fall is clouding your judgement. I also want them to fall. They will do so, in spite of government attempts to cushion the effects of recession. Your suggestions will inflict unnecessary misery on millions of people for years to come.

Young Mark

Anonymous said...

I am happy to have the Japanese solution: massive asset deflation, zombie banks and a lost decade. It wouldn't hurt me one bit.